DERIVATIVE FINANCIAL INSTRUMENTS:

The Company actively monitors its exposure to interest rate and foreign currency exchange rate risks and uses derivative financial instruments to manage the impact of certain of these risks. The Company uses derivatives only for purposes of managing risk associated with underlying exposures. The Company does not trade or use instruments with the objective of earning financial gains on the interest rate or exchange rate fluctuations alone, nor does the Company use derivative instruments where it does not have underlying exposures. Complex instruments involving leverage or multipliers are not used. The Company manages its hedging position and monitors the credit ratings of counterparties and does not anticipate losses due to counterparty nonperformance. Management believes its use of derivative instruments to manage risk is in the Company’s best interest. However, the Company’s use of derivative financial instruments may result in short-term gains or losses and increased earnings volatility. The Company’s instruments are recorded in the consolidated balance sheets at fair value in prepaid expenses and other, other assets, net, accrued expenses or other long-term liabilities.

The Company may designate derivatives as a hedge of a forecasted transaction or a hedge of the variability of the cash flows to be received or paid in the future related to a recognized asset or liability (cash flow hedge). The portion of the changes in the fair value of the derivative used as a cash flow hedge that is offset by changes in the expected cash flows related to a recognized asset or liability (the effective portion) is recorded in other comprehensive income/(loss). As the hedged item is realized, the gain or loss included in accumulated other comprehensive income is reported in the consolidated statements of operations on the same line item as the hedged item. The portion of the changes in the fair value of derivatives used as cash flow hedges that is not offset by changes in the expected cash flows related to a recognized asset or liability (the ineffective portion) is immediately recognized in earnings on the same line item as the hedged item.

The Company matches the hedge instrument to the underlying hedged item (assets, liabilities, firm commitments or forecasted transactions). At inception of the hedge and at least quarterly thereafter, the Company assesses whether the derivatives used to hedge transactions are highly effective in offsetting changes in either the fair value or cash flows of the hedged item. When it is determined that a derivative ceases to be a highly effective hedge, the Company discontinues hedge accounting, and any gains or losses on the derivative instrument thereafter are recognized in earnings during the periods it no longer qualifies as a hedge.

From time to time, the Company may enter into certain derivative instruments that may not be designated as hedges for accounting purposes. For example, to mitigate currency exposures related to intercompany debt, cross-currency swap contracts may be entered into for periods consistent with the underlying debt. The Company believes such instruments are closely correlated with the underlying exposure, thus reducing the associated risk. The gains or losses from the changes in the fair value of derivative instruments not accounted for as hedges are recognized in current period earnings within other income/(expense), net.

Interest Rate Risk Management

The Company uses interest rate swap agreements to manage its exposure to changes in interest rates of the Company’s variable rate debt. These swap agreements are recorded in the consolidated balance sheets at fair value. Changes in the fair value of the swap agreements are recorded in net income or other comprehensive income/(loss), based on whether the agreements are designated as part of a hedge transaction and whether the agreements are effective in offsetting the change in the value of the future interest payments attributable to the underlying portion of the Company’s variable rate debt. Interest payments accrued each reporting period for these interest rate swaps are recognized in interest expense. The Company formally documents its hedge relationships, including identifying the hedge instruments and hedged items, as well as its risk management objectives and strategies for entering into the hedge transaction.

In the fourth quarter of 2008, the Company entered into an interest rate swap agreement to manage its exposure to interest rates on a portion of its outstanding borrowings. The swap has a notional amount of $120.0 million and requires the Company to pay a fixed rate of 3.88% on the notional amount. In return, the Company receives one-month LIBOR on the notional amount of the swap, which is equivalent to the Company’s variable rate obligation on the notional amounts under the New Credit Agreement. This swap expires on September 30, 2013.

In the fourth quarter of 2012, the Company entered into multiple interest rate swap agreements to manage its exposure to changes in interest rates on its variable rate debt. The following table summarizes the terms of the interest rate swap agreements (dollars in thousands):

Notional Amount

Effective Date

Expiration Date

Date

Amount

Pay Fixed Rate

Receive Variable Rate

10/4/2012

9/30/2013

10/4/2012

1,450,000

0.25%

1-month LIBOR

1/1/2013

1,350,000

0.25%

1-month LIBOR

4/1/2013

1,300,000

0.25%

1-month LIBOR

7/1/2013

1,250,000

0.25%

1-month LIBOR

9/30/2013

9/29/2014

9/30/2013

1,350,000

0.35%

1-month LIBOR

12/31/2013

1,300,000

0.35%

1-month LIBOR

3/31/2014

1,250,000

0.35%

1-month LIBOR

6/30/2014

1,200,000

0.35%

1-month LIBOR

9/30/2014

9/29/2015

9/30/2014

1,150,000

0.54%

1-month LIBOR

1/1/2015

1,100,000

0.54%

1-month LIBOR

4/1/2015

1,050,000

0.54%

1-month LIBOR

7/1/2015

1,000,000

0.54%

1-month LIBOR

9/30/2015

9/30/2016

9/30/2015

350,000

0.93%

1-month LIBOR

On November 9, 2012, the Company entered into multiple 10-year forward starting interest rate swap agreements to manage its exposure to changes in interest rates on its variable rate debt. On the date of the hedge designation, September 30, 2016, it is probable that the Company will either issue $300.0 million of fixed-rate debt or have $300.0 million of variable-rate debt under its commercial banking lines. The forward starting interest swap agreements are expected to settle in cash on September 30, 2016. The Company expects any gains or losses on settlement will be amortized over the life of the respective swaps. The swaps have a notional amount of $300.0 million and require the Company to pay a fixed rate of 2.79% and receive three-month LIBOR on the notional amount over a 10-year period expiring September 30, 2026.

The fair value of the interest rate swap agreements were estimated based on Level 2 inputs. The Company’s effectiveness testing during the year ended December 31, 2012 resulted in no amount of gain or loss reclassified from accumulated other comprehensive income/(loss) into earnings. See Note 17, Accumulated Other Comprehensive Income, for additional information regarding the Company's cash flow hedges.

Foreign Currency Exchange Rate Risk

As of December 31, 2012, $220.9 million of third-party debt related to the Company’s foreign operations was denominated in the currencies in which its subsidiaries operate, including the Australian dollar, Canadian dollar and Euro. The debt service obligations associated with this foreign currency debt are generally funded directly from those operations. As a result, foreign currency risk related to this portion of the Company’s debt service payments is limited. However, in the event the foreign currency debt service is not paid from the Company's foreign operations, the Company may face exchange rate risk if the Australian or Canadian dollar or Euro were to appreciate relative to the United States dollar and require higher United States dollar equivalent cash.

The Company is also exposed to foreign currency exchange rate risk related to its foreign operations, including non-functional currency intercompany debt, typically from the Company’s United States operations to its foreign subsidiaries, and any timing difference between announcement and closing of an acquisition of a foreign business to the extent such acquisition is funded with United States dollars. To mitigate currency exposures related to non-functional currency denominated intercompany debt, cross-currency swap contracts may be entered into for periods consistent with the underlying debt. In determining the fair value of the derivative contract, the significant inputs to valuation models are quoted market prices of similar instruments in active markets. To mitigate currency exposures of non-United States dollar denominated acquisitions, the Company may enter into foreign exchange forward contracts. Although these derivative contracts do not qualify for hedge accounting, the Company believes that such instruments are closely correlated with the underlying exposure, thus reducing the associated risk. The gains or losses from changes in the fair value of derivative instruments that are not accounted for as hedges are recognized in current period earnings within other income/(expense), net.

On December 1, 2010, the Company completed the FreightLink Acquisition for A$331.9 million (or $320.0 million at the exchange rate on December 1, 2010). The Company financed the acquisition through a combination of cash on hand and borrowings under its credit agreement then in effect. On November 24, 2010, the Company entered into foreign exchange forward contracts, with funds to be delivered on December 1, 2010, to secure an exchange rate for A$45 million of the A$331.9 million purchase of the FreightLink assets. The subsequent decrease in the value of Australian dollar versus the United States dollar between November 24, 2010 and December 1, 2010 and its impact on the A$45 million of purchase price resulted in an additional expense of $0.7 million within other income/(expense), net.

In addition, a portion of the funds were transferred from the United States to Australia through an intercompany loan with a notional amount of A$105.0 million (or $100.6 million at the exchange rate on December 1, 2010). To mitigate the foreign currency exchange rate risk related to this non-functional currency intercompany loan, the Company entered into an Australian dollar/United States dollar floating to floating cross-currency swap agreement (the Swap), effective as of December 1, 2010, which effectively converted the A$105.0 million intercompany loan receivable in the United States into a $100.6 million loan receivable. The Swap required the Company to pay Australian dollar BBSW plus 3.125% based on a notional amount of A$105.0 million and allowed the Company to receive United States LIBOR plus 2.48% based on a notional amount of $100.6 million on a quarterly basis. BBSW is the wholesale interbank reference rate within Australia, which the Company believes is generally considered the Australian equivalent to LIBOR. As a result of these quarterly net settlement payments, the Company realized a net expense of $4.4 million within interest (expense)/income for the year ended December 31, 2012. In addition, the Company recognized a net gain of $0.6 million within other income/(expense), net related to the settlement of the derivative agreement and the underlying intercompany debt instrument to the exchange rate for the year ended December 31, 2012. The Swap expired on December 1, 2012 and was settled for $9.1 million.

On November 29, 2012, simultaneous with the termination of the existing swap, the Company entered into two new 2-year Australian dollar/United States dollar floating to floating cross-currency swap agreements (the Swaps), effective December 3, 2012. These agreements expire on December 1, 2014. The Swaps effectively convert the A$105.0 million intercompany loan receivable in the United States into a $109.6 million loan receivable. The Swaps require the Company to pay Australian dollar BBSW plus 3.25% based on a notional amount of A$105.0 million and allow the Company to receive United States LIBOR plus 2.82% based on a notional amount of $109.6 million on a quarterly basis. As a result of these quarterly net settlement payments, the Company realized a net expense of $0.3 million within interest (expense)/income for the year ended December 31, 2012. In addition, the Company recognized a net loss of $0.3 million within other income/(expense), net related to the settlement of the derivative agreement and the underlying intercompany debt instrument to the exchange rate for the year ended December 31, 2012.

Contingent Forward Sale Contract

In conjunction with the Company's announcement on July 23, 2012 of its plan to acquire RailAmerica, the Company entered into the Investment Agreement with Carlyle in order to partially fund the acquisition of RailAmerica. Pursuant to the Investment Agreement, the Company agreed to sell to Carlyle a minimum of $350.0 million of Series A-1 Preferred Stock. Each share of the Series A-1 Preferred Stock was convertible at any time, at the option of the holder, into approximately 17.1 shares of Class A common stock, subject to customary conversion adjustments. The Series A-1 Preferred Stock was also convertible into the relevant number of shares of Class A common stock on the second anniversary of the date of issuance, subject to the satisfaction of certain conditions. Furthermore, the Company had the option to convert some or all of the Series A-1 Preferred Stock prior to the second anniversary of the date of issue of the Series A-1 Preferred Stock if the closing price of the Company's Class A common stock on the New York Stock Exchange exceeded 130% of the conversion price (or $76.03) for 30 consecutive trading days, subject to the satisfaction of certain conditions. The conversion price of the Series A-1 Preferred Stock was set at approximately $58.49, which was a 4.5% premium to the Company's stock price on the trading day prior to the announcement of the RailAmerica acquisition.

For the period between July 23, 2012 and September 30, 2012, the Series A-1 Preferred Stock was accounted for as a contingent forward sale contract with mark-to-market non-cash income or expense included in the Company's consolidated financial results and the cumulative effect represented as an asset or liability. As a result of the significant increase in the Company's share price between July 23, 2012 and the end of the third quarter of 2012, the Company recorded a $50.1 million non-cash mark-to-market expense to the Investment Agreement for the twelve months ended December 31, 2012. The closing price of the Company's Class A common stock was $66.86 on September 28, 2012, which was the last trading day prior to issuing the Series A-1 Preferred Stock.

On February 13, 2013, the Company converted all of the outstanding Series A-1 Preferred Stock into Class A common stock (see Note 24, Subsequent Events).

The following table summarizes the fair value of derivative instruments recorded in the consolidated balance sheets as of December 31, 2012 and 2011 (dollars in thousands):



		Fair Value
	Balance Sheet Location	2012		2011
Asset Derivatives:
Derivatives designated as hedges:
Interest rate swap agreements	Other assets, net	$	4,302	$	—
Derivatives not designated as hedges:
Cross-currency swap agreements	Prepaid expenses and other	$	255	$	—
Liability Derivatives:
Derivatives designated as hedges:
Interest rate swap agreements	Accrued expenses	$	3,778	$	4,143
Interest rate swap agreements	Other long-term liabilities	885		2,882
Total derivatives designated as hedges		$	4,663	$	7,025
Derivatives not designated as hedges:
Cross-currency swap agreements	Accrued expenses	$	—	$	7,170
Cross-currency swap agreements	Other long-term liabilities	143		—
Total derivatives not designated as hedges		$	143	$	7,170

The following table shows the effect of the Company’s derivative instrument designated as a cash flow hedge for the years ended December 31, 2012 and 2011 in other comprehensive income/(loss) (OCI) (dollars in thousands):



	Total Cash Flow Hedge OCI Activity, Net of Tax
	2012		2011
Derivatives Designated as Cash Flow Hedges:
Effective portion of changes in fair value recognized in OCI:
Interest rate swap agreement	$	4,053	$	1,334

The following table shows the effect of the Company’s derivative instruments not designated as hedges for the years ended December 31, 2012 and 2011 in the consolidated statements of operations (dollars in thousands):



		Amount Recognized in Earnings
	Location of Amount Recognized in Earnings	2012			2011
Derivative Instruments Not Designated as Hedges:
Cross-currency swap agreements	Interest (expense)/income	$	(4,638	)	$	(5,935	)
Cross-currency swap agreements	Other income/(expense), net	303			246
Contingent forward sale contract	Contingent forward sale contract mark-to-market expense	(50,106		)	—
		$	(54,441	)	$	(5,689	)